creating

wealth
with

mutual funds

Creating Wealth with

Mutual Funds

Contents

Why mutual funds.......................................................................................................................... 2

Cost of acquisition ........................................................................................................................ 2
The first step................................................................................................................................... 3
Power of compounding................................................................................................................. 4
Selection of funds........................................................................................................................... 4
Savings through SIP....................................................................................................................... 6
Grow wealth with equity MFs....................................................................................................... 7
Options within equity.................................................................................................................. 10
Securing wealth with debt funds..................................................................................................11
Tax-saving MFs and wealth creation...........................................................................................11
MFs for buying home...................................................................................................................12
MFs for your childrens future......................................................................................................13
MFs for your retirement.............................................................................................................. 14
Choosing funds on the basis of age........................................................................................... 14
Managing the portfolio............................................................................................................... 16

Content by

Outlook Money

Creating wealth
with

Mutual funds
It doesnt matter whether you are an aggressive or a conservative investor.
Mutual funds help create wealth for your long- and mid-term goals

he general perception is that if

one had more money at ones
disposal, one would have a better plan to use it properly. However, the reality is if you have a better
plan, you would make more money.
Most of us believe that it is necessary
to secure our and our familys future,
but what prevents us from doing this
is the lack of funds. This is where most
of us go wrong and miss the earlybird advantage. However, with the
right planning and approach, you too
can achieve your financial goals with
whatever little you mange to save.
Mutual funds (MFs) provide a safe and
easy option in creating wealth. Here is
a step-by-step guide to help you create
wealth through MFs

various assets, such as equity, debt

or gold. Based on ones financial goal
or risk appetite, there are several MF
schemes to choose from. Some of the
key features of MFs are simplicity, affordability, professional management,
diversification and liquidity. MFs give
investors the flexibility to invest in
the various asset classes. Also, unlike
several other financial products, MFs
give you the freedom of not having to
invest on a continuous basis. You can
stop your investment in an MF scheme
when there is no cash flow. That said,
your invested amount will have the
potential to grow till you decide to
liquidate it.

Why Mutual Funds

MFs also give you the freedom from

tracking the stockmarket on a daily
basis to search for the right stock at a
fair price and right valuation, as well

An MF is a financial product that

pools money from different individuals and invests it on their behalf into
2

Low cost of acquisition

of high quality assets

Creating Wealth with

Mutual Funds

as the need to monitor economic policies and news that affect stocks and
the various sectors you have invested
in through direct equity or MFs.
One of the biggest benefit of MF
investments is that you dont need
to be a financial expert. The investment decision is taken by investment
experts, such as fund managers, who
help you manage your money professionally. In lieu for their services,
sector regulator Sebi has allowed them
to charge a small percentage of the
entire corpus money that they manage
in the MF scheme, making MFs very
cost-efficient. These, together with the
flexibility to invest in either a lump
sum or in small amounts, makes MFs
one of the best instruments to create
wealth over the long term. As mentioned earlier, the flexibility to invest in
various asset classes and the freedom

from having to invest on a continuous

basis, do not affect your cash reserves
drastically and your invested money
has a growth potential that you could
depend on. Therefore, MFs are an
excellent tool for creating wealth over
the long term.

The First step

Budgeting. Budgeting will help you

keep your purse strings tight. This

effectively translates into savings that
you can invest for your long term
financial goals, such as home buying,
childrens education and your own
retirement. Budgeting helps you to cut
down your bills, such as telephone,
grocery and the like. This will also help
you in reducing the frequent expenditure on outings, movies and dinning at
restaurants. In effect, you will be able
to put a fix on your regular expenses

every month and the amount you can

save (were you to cut down on certain
expenses) and channelise the same
into your investments.
Savings and investments. Merely
saving will not help you create wealth,
unless you invest it into financial instruments that can generate inflationbeating returns. Also, the earlier you
start investing, the more wealth you
can create. An early beginning in all
walks of life is a good recipe for success
and the same holds true for investing. Early birds have an advantage
over those who are off the blocks late.
They manage to save a decent pile
for all their requirements with less
hassles. The essence is to invest early
and remain invested for long, so that
your money gets the maximum time to
grow to the required levels and at the
required time.

Power of compounding
Power of compounding gives you the
edgethe more time your money
gets to grow, the more you gain. If
you start saving early, even in small
amounts, it will help you build a sizeable corpus. The rule is to invest regularly and keep investing the returns.
As a result, your earnings will also
participate in getting more returns.
For example: X starts investing `2,500
per month at 25 years, while Y, who is
of the same age as X starts investing
`5,000 per month ten years later. When
both X and Y turn 45, X would have
amassed a sizeable corpus of `22.78
lakh, while Y will have only half as much
(`11.09 lakh), i.e., on a 12 per cent
4

return, despite Y investing more than X.

An early start to investing in equity

MF schemes also inculcates discipline
as you invest regularly. Stockmarkets remain volatile on the short-tomedium term, but average-out over
the longer horizon. An investor, who
remains invested over the long term
even during the ups and downs of the
stockmarket, is largely unaffected.
And, most importantly, mistakes made
during the initial days helps one learn
the basics of investing, which in turn,
helps you become a mature investor.

Selection of funds
Although investing in an MF scheme
relatively carries less risk compared
to investing directly in the capital
market, one must exercise caution
while selecting the right MF scheme,
especially if the investment is for meet-

Creating Wealth with

Mutual Funds

ing long-term goals. One must assess

the targeted MF schemes on certain
criteria.
Performance over long term. Consistency pays over the long term. So,
instead of choosing a fund on their
short-term performance, one should
look at their long-term performance.
This will give you an idea of how the
fund has performed during different market conditions. That said, the
performance of schemes within the
same fund family may vary as they are
managed by different fund managers
and different schemes have different
objectives. So, take a close look at the
targeted schemes performance vis-vis its benchmark and its peers.
MFs and your risk profile. You can
rank the various schemes on a riskreturn scale. In descending order of

risks, sector-specific schemes top the

list. These are followed by growth
schemes, balanced schemes, debt
schemes and gilt schemes.
No matter how aggressive ones risk
profile is to take exposure in equities,
the lesser volatile debt asset always remains an essential component of ones
investment portfolio. Choosing the
right debt fund can be important as
they can either be long-or short-term
funds and, therefore, should match
your financial requirement.
For goals which are about three years
away, park in long-term income funds
which hold securities of longer durations. Portfolios with higher maturity
could earn better returns in a falling
interest rate scenario and volatility is
capped as funds are not exposed to equities. For goals less than three years,
use short-term debt funds. When the
requirement for funds is within a year,
look at liquid funds. These funds along
with ultra short-term debt funds can
also be considered for requirements
arising in 3-6 months. Parking funds
in debt funds as per the tenure of the
goal also adds tax advantage when
compared to bank fixed deposits especially for investors in highest tax slab.
Most MF schemes offer a choice
between a growth and a dividend option. If your objective is to accumulate
wealth, choose the growth option. But,
even if you opt for a dividend plan, you
can choose the reinvestment facility,
wherein the dividend is automatically
reinvested in the scheme.
In a nutshell, play by the rules while

drawing up an MF portfolio.

Categories and how they work. You

must know the broad categories of

schemes, their purpose and how they
work. For instance, you must know the
difference between income funds and
gilt fundswhat they invest in, what
influences their performance and the
kind of returns they are likely to deliver. This will help you zero in on the
schemes that match your risk profile
and investment objective.

Respect your risk-taking capacity.

Dont go overboard with equities if you

are not comfortable taking on the risk
involved. Keep your bigger investment
goals (buying a car, house, your own
wedding expenses, childrens education
and their wedding, and your retirement) in mind when you draw up your
portfolio. For instance, if the goals are
in the distant future, you may take
certain risks and invest the money in
equity funds. Equities have the potential to outperform all other asset classes
over the long term.
Diversifying your portfolio. Dont
diversify just for the sake of diversification. There should be a logic to it
what you want from your investment
and how much risk you are willing to
take. Dont over-diversify within asset
classesthree schemes in a category
at most. One of the primary reasons
to opt for MFs is that you dont want
to spend a lot of time on your investments. But thats what youll end up
doing if you diversify your corpus
across too many schemes. Moreover,
the incremental diversification benefit
keeps falling with each new scheme
6

you invest in within a category. So,

keep your broad asset mix in mind, but
allow flexibility to capitalise on opportunities of a dynamic market.

Regular savings: SIP Way

A systematic investment plan (SIP)
allows an investor to invest a specific
amount in an MF scheme of his or her
choice over a certain period. While
SIPs are available for all MF schemes,
they are most effective in equity
schemes, as they are a more volatile
asset class than debt. SIPs help in
regular savings as well as in riding on
the volatility of the equity market.
An ideal way to profit from stockmarket volatility is to buy units when
it is trading low and sell them when
it is at a high. But thats easier said
than done. It is here that SIPs come in
handy. They help an investor buy more
units when prices are falling and fewer
units when prices are rising. When the
net asset value (NAV) of an MF scheme
falls because of a stockmarket crash,
you accumulate more units at lower
rates, while in a rising stockmarket
you are allotted fewer units.
Over long periods, SIPs help lower
the average purchase price of units.
At most times, your average unit cost
will always be below your average sale
price per unit, irrespective of whether
the stockmarket is rising or falling.
Only in extremely bearish phases will
an SIP investor book a loss.
Technically, SIPs keep the average
purchase price of units down, without having you to second-guess the
stockmarket situation. Besides, the in-

Creating Wealth with

Mutual Funds

vestment in instalments (since an SIP

investment involves investing a fixed
amount at regular intervals into an
MF scheme), help you achieve a higher
return from equities than other investment methods. SIPs are most-effective
over long periods of timethe investor
profits from the appreciation equities
tends to show over the long term.

Make your wealth grow

with equity MFs
Schemes that invest in equity shares
of companies are called equity MF
schemes. As an asset class, equities
have the potential of providing high
returns with an acceptable levels of
risk, but the challenge lies in understanding the behaviour of equity
markets over a long period of time
not a year or three, but at least over a
decade or more.
Though volatile in nature, equity as

an asset class has delivered

the best returns over a 10- or
15-year period or more. In
the last 10 years, the average
return from equity funds has
been more than 20 per cent
(source: Icra). So, if you are
investing for your long-term
financial goals, equity is a
must-have in your portfolio.
But in the short-run, the risk
of investing in equities is far
more. The last few years witnessed a volatile stockmarket
and this might have eroded
your capital. Also, in order to
create wealth over the long
term, one needs to put savings
into assets that can deliver inflationbeating returns. Or else, inflation will
eat into your returns and it will not
help you in accumulating the corpus
to see you through. Whatever the risk
profile or the quantum of savings you
may have, its imperative to use equitybacked investment products to cancel
the effect of inflation.
The veracity of using equity to meet
long-term goals have been proven time
and again. Studies done in the past
have shown that equity has delivered
higher inflation-adjusted return than
any other asset class. The underlying
message is the time horizonthe longer one remains invested in equities,
the better is the return. As mentioned
earlier, the advantage comes from the
power of compounding because the
earlier you start, the more time your
money gets to grow. If you start saving

early, even in small amounts, it

will help build a sizeable savings
portfolio.
One must begin investing in
equity through MFs. Investing
into direct equity (stockmarket)
with little or no knowhow could
be disastrous. That said, an early
beginning in investing through
equity MF also inculcates a disciplined and safe way of navigating the volatile stockmarket.

Options within equity

Equity MFs come with multiple
variations within the category,
depending on the type of stocks they
use to build the portfolio. Needless
to say, the risks associated with each
equity MF scheme also vary.
Depending on the objective of an MF
scheme, the fund manager invests in
small-, medium- or large-cap stocks
or in a mix of the three. Each fund has
its own distinguishing objective and
a risk-reward grid. So, understanding
them is important in order to align
ones financial objective with that of
the fund to generate optimum result.
Large-caps. Typically, a large cap MF
would invest in the shares of companies that have a market capitalisation
(market price of share multiplied by
shares outstanding) of more than
`5,000 crore. Generally, these funds
are well-diversified among the top
30, 50, 100 or 200 stocks, and stick to
stocks that have a high level of trading
volumethus, imparting enough
liquidity to the portfolio. These are the
least-risky among diversified equity
10

funds, as shares of large-cap companies are considered to be among the

best-known and most researched.
They provide stable growth during
periods when the stockmarkets are in
a bull phase and tend to have lesser
declines during downturns. Ideally,
these funds should form the core of
your investment portfolio and will be
the main growth engine.
Mid- and small-caps. MF schemes
that invest in shares with a market
capitalisation of anywhere between
`1,000 crore and `5,000 crore are
mid-cap funds. Small-cap funds target
those with lower market capitalisationanything less than `1,000
crore. Mid- and small- cap funds are
more risky as they invest in relatively
smaller companies, which are in the
growing stage and may be under-researched. As such, funds venture into
the relatively unknown, and, therefore, the risk-reward ratio is also high.
The mid- and small-cap segment is a

Creating Wealth with

Mutual Funds
good investment opportunity for longterm investors who have considered
both the returns and the risks. Before
you decide to invest in a mid-cap fund,
remember that it cannot form the
foundation of your portfolio. It should
be included only to the extent permitted by your risk profile to enhance the
returns from your portfolio.
Multi-cap. While its the large-caps
that take the centrestage, at times,
mid-caps are considered favourites.
Typically, no investor should change
his or her MF portfolio to reflect the
current stockmarket trends, since
equity MF investments are always
made to fulfil long-term financial
goals. But, sometimes, to cater to such
immediate tweaks in the portfolio, one
may consider multi-cap funds, which
invest across the spectrum of market
capitalisation with a mix of large- and
mid-cap stocks.

equity in one go.

STABILISING YOUR WEALTH

WITH DEBT FUNDS

An MF investment also helps in planning ones taxes and thereby reducing

the tax burden. Investing in specific
MF schemes called Equity-linked Savings Schemes, popularly known as
ELSS, reduces ones taxable income
by the amount invested (up to `1 lakh
as per Section 80C of the Income Tax
Act, 1961) and, thereby, reduces his
or her tax liability. ELSS could be the
starting point for new investors, as
it offers market-linked returns with
shorter lock-in period, as well as the
benefits of tax-saving.
ELSS can be used for creating wealth
to meet your long-term financial goals.

Derisking. Putting to use debt funds

during the derisking phase helps. With
about three years away from meeting
your goal, start shifting funds from
volatile equity into less volatile debt
funds. Either switch funds in lump
sum or use the systematic transfer
plan (STP) to shift funds from equity to
debt funds. The STP mandate will shift
funds from existing equity scheme to
any debt scheme of same fund house
or another over regular period such as
monthly or quarterly. As the shifting
is staggered not all funds move out of

Regular income for retirees. Debt

funds may be put to use by retirees too
especially when they depend on regular income. For this use the systematic
withdrawal plan (SWP), mostly available with debt schemes to fetch regular
income. Basically, its a payment plan
that lets you withdraw pre-decided
amounts from your investments at
periodic intervals. There are two options in an SWPfixed withdrawals,
in which you specify the amounts you
wish to withdraw from your investment on a regular basis, and appreciation withdrawal, in which you can
withdraw your appreciated amount.
For those in the highest tax bracket,
the fixed withdrawal option is more
suitable and that too after holding on
to the scheme for a year.

tax-saving Mutual funds

to create wealth

11

As the name suggests, an ELSS is a

savings scheme thats linked to equity.
Investment avenues for your savings
can be a mix of various asset classes,
such as equity, debt, gold and real estate. Technically, an ELSS is similar to
any diversified equity MF, which routes
your investments into the equity
markets. Like any other MF scheme,
ELSS is also managed by professionals known as fund mangers. It stands
apart from a normal MF as it carries
a tax benefit on the amount invested
and, thereby, has a lock-in period of
three years. Before you invest in an
ELSS, estimate your total tax liability
for the year. Then, based on your risk
profile, choose among various tax savings instruments, including ELSS, and
link it individually to your long-term
goals. If properly chosen and cautiously maneuvered, ELSS can be a
good kicker in your MF portfolio over
the long term.

MFs for home-buying

For all of us who are still living in
rented accommodation, the major
irritant is spending our hard-earned
money on rent (an expense), when we
can probably pay the same, or a little
more, as equated monthly instalments
(EMIs) to service a home loan and help
build ones home. This becomes all the
more important given that property
prices have settled down a bit and
home loans are cheaper than before.
Housing finance companies are also
falling over each other to woo you.
Owning a home is a compelling goal,
and saving for a downpayment is
12

certainly a priority. If you feel that it is

the right time for you to buy a house,
create a savings plan for your downpayment. Get an idea of the purchase
price and the EMI payments you can
afford. Estimate what youll need for a
downpayment and, thereafter, calculate the amount of savings you need
every month at a reasonable return of
about 12 per cent per annum.
Taking adequate risk when time
horizon is less. If the time horizon is

less, i.e., just a year or so away, it is better to stash funds in a money-market

or liquid fund. Choose the fund and
start saving under the growth option
through SIP. Ideally, keep the portfolio
tilted towards debt, as equities usually
perform well over the long term, but
is considered a risky asset class in the
short term. There are balanced funds
to suit this situation. Balanced or
hybrid funds, as the name suggests,
allocate assets in their portfolio to both
equity and debt. The equity component provides the power of returns,
while debt provides stability against
stockmarket volatility. Such funds will
not rise as much as a pure equity fund,
but will not fall as much either. If your
goal is further away, you can consider
taking higher risk and invest in diversified equity fundschoose large-caps
and ensure you shift to less volatile
debt funds at least two years before
reaching your goal.
Choosing the right funds. A balanced fund plays the role of a joker
that can complete any winning hand
in a card game. It can be used for a
host of investment functionsasset

Creating Wealth with

Mutual Funds

allocation and diversification, portfolio rebalancing and for earning

equity-linked returns with lower
volatility than pure equity funds. A
portfolio diversified across various
asset classes shows greater stability
in returns than one that invests only
in one asset class. This is so because
none of the asset classes consistently
performs well over all time frames. So,
a portfolio that is diversified between
equity and debt will benefit from the
performance of any of the asset classes
in your portfolio. Technically, investment in a balanced fund allows one to
hold a diversified portfolio. However,
it is important to evaluate and track
the performance of the funds and the
fund manager should also take care to
rebalance the fund allocation between

equity and debt, as and when required.

Investors, who do not want to take
the pains of a funds performance and
manage portfolio allocation between
asset classes, should invest only in
balanced funds with suitable asset
allocation, where the fund manager
periodically rebalances the portfolio to
the stated allocation.

Mfs For Childrens future

When it comes to taking the MF
route to planning for your childrens
future, you must follow the same
basic principals as those for your own
long-term financial planning. This
goal is also long-term and equities
give you the best option to reach your
destination. And, again, if you do not
have the expertise or the will to spend

13

time tracking equity markets directly,

take the MF route. Also, investment
in MFs are one of the best regulated
instruments in the stockmarket today,
which do not require your day-to-day
involvement.
Plan early. Like any other investment
planning, the ideal time is to start
early, i.e., as soon as your child is born.
School fees may not be a big burden,
but you will certainly have to save
a substantial amount for his or her
higher studies and wedding expenses.
So, the sooner you start, the more time
your savings will get to grow.

MFs For retirement

Retirement is one financial goal that
largely takes a back seat for most of us,
but those who pay attention to it early
on in their life stand to gain. With
life expectancy on the rise, the nonearning period in ones life is bound to
put that much strain on your retirement years if you do not plan for it in
advance. So, remember, the earlier you
start, the lesser you will have to save
regularly and equity MFs are just right
vehicle for it to achieve your desired
retirement corpus.

Choosing funds Age-wise

The 20s investor. If you start

i nvesting as soon as you get your first

job, it would certainly be easier for you
because you will have fewer financial responsibilities and can afford
to take risks. There is also an added
advantage: you will be in a position to
address any mid-course corrections to
your portfolio without major hassles.
14

So, when you start out and are

game to take risks, your portfolio
should be heavy on equity funds
around 80 per cent. But, if you
believe in conservative investing,
you can allocate 60 per cent to
equity funds. As a new investor, start
investing in exchange-traded funds
(ETFs) and index funds. ETFs and
index funds invest in the same stocks
and in similar proportion as they lie in
their benchmark indicesBSE Sensex
or the NSE Nifty. They are passively
managed with an aim to reflect stockmarket returns.
Try large-cap equity funds, which
invest in well-established, top-rung
companies and are less volatile, because they are actively managed and
have the potential to beat the stockmarket returns. Aggressive investors

Creating Wealth with

Mutual Funds

can invest up to 30 per cent of their

equity portfolio in mid-cap and smallcap funds.
The 30s investor. As you move up
the ladderyou might have more or
less settled down in life with a higher
pay package, but also with more
dependants: especially if you are married and have children, and, perhaps,
parents to supportyour financial
responsibilities will also increase, and
to cater to those needs while keeping
your capital safe you need to move
towards safer assets, such as debt and
reduce your dependence on equity.
At the same time, you need to invest
for your long-term goals, such as a
house, funding your childrens education and your own retirement needs.
Lessen your dependence on equity

down to 70 per cent if you are an

aggressive investor and 40 per cent
if you are conservative. Conservative
investors should stick with diversified
equity funds; and the ones with more
risk appetite must consider mid-cap,
small-cap and sectoral funds to get better returns on their overall portfolio.
In your 30s, or even later, as you
scale down your equity exposure, you
should review your outlook on debt
fundsthey must now be seen as
growth vehicles. Now, all your incremental debt fund allocation should
flow into income funds.
The 40s investor. Your expenses tend
to peak at this stage of your life. You
may still be having some
medium-term goals to provide for
(a house or your childrens higher
education), and, at the same time, you
would also have to proactively plan for
your retirement. Therefore, you need
to contain risk and, while doing so,
ensure your retirement corpus grows
substantially to with inflation-beating
returns. To negotiate this tightrope,
the aggressive investor should go with
a perfectly balanced exposure to debt
and equity. However, if you are risk
averse, allocate 10-20 per cent more in
debt. Irrespective of what your risk appetite is, this is the time to scale down
your equity exposure and explore debt
instruments that would provide stability of returns, such as floating-rate
funds and fixed-maturity plans.
The 50s investor. By now, you have
either met most of your big-money
financial goals or are on the verge to

15

close on them, save your retirement.

Whatever the case may be, this is the
time to give top priority to secure your
retirement by ensuring the safety of
your capital and wait for the right time
to migrate your money from riskier
equity to safer debt instruments. How
much you want to move will depend
on your risk orientation as well as
whether you are planning for a second
career in retirement. If you expect to
keep earning, you may risk a higher
equity exposure. If you intend to live
off your investments, increase your
allocation to debt instruments.
Remember, debt MF schemes offer
some advantage over other fixed
income instruments. If you opt for
dividend, it is tax-free, however, if you
opt for growth option you will have
to pay short-term capital gain (STCG)
tax or long-term capital gain (LTCG)
tax if you sells the units before a year
or after a year, respectively. STCG tax
is calculated as per your tax slab and
the LTCG tax is calculated at 10.30 per
cent without indexation, or 20.60 per
cent with indexation.
16

Managing the portfolio

Monitor your portfolio regularly and
track the performance of the MF
schemes you have invested in. Track
your schemes NAV every six or 12
month a and look for changes in
the portfolio. Compare the schemes
performance with that of the Sensex,
or its peers.
If your schemes have not done well
for a over year or two, find out whether
it is because of a depressed capital
market or due to reasons specific to
your schemes performance. Dont
get hassled if your scheme underperforms in a runaway market. But, if it
is underperforming in a falling market
(the fall in the schemes NAV is greater
than the fall in the benchmark index),
review your investment.
You must read the fund managers
comments in the newsletters and
the annual report. Ensure the fund is
adhering to the objectives stated in the
scheme information document. Also,
keep track of various periodic statements, such as newsletters, half-yearly
and annual reports. r